We get it, interest isn’t the most interesting topic of conversation, and you probably haven’t thought much about compound interest since high school maths. But having a good grasp on what compound interest is, and how an account that earns compound interest can increase your savings, is something handy to learn – future you will thank you for it.
What is compound interest?
It’s essentially interest on interest. You make an initial deposit into something like a savings account. You earn interest which gets added to your deposit. Then, you can start earning interest on both your initial deposit and the interest you’ve been paid. The cycle continues and this becomes an ongoing, compounding amount.
Compound interest is different to simple interest. With simple interest, you will only get interest on the initial deposit into your account. You won’t get interest on the previous interest you’ve earned.
Here’s an example of compound interest
Compound interest becomes a powerful tool if you regularly add contributions. Say you start with $500 and make a deposit of $50 every month over 10 years into an account that earns compound interest at a rate of 5.00% p.a.
By the end of the 10 years, you would have put away $6,000 in your own deposits and earned $2,088 in interest.
When you’ve already got a decent chunk of savings, and you’re in the position to make higher contributions month on month, the compound interest becomes even more sizeable.
So let’s say you start out with a $5,000 deposit and this time make deposits of $100 every month into an account with the same rate (5.00% p.a.). If you continued this for 10 years, you would have put away $12,000 of your own deposits and earned $6,763 in compound interest.
Time is on your side
Where compound interest really gets interesting is when you give yourself the gift of time and allow it to play a major role in your savings plan.
Take the most recent monthly saving example (a $5,000 initial deposit with $100 month deposits at 5.00% p.a.), but extend the timeframe to 35 years (which might coincide with the average retirement age (65) for someone who’s just turned 30).
At the end of the 35 years you’d have deposited $42,000of your own savings and earnt a total of $95,278 in compound interest.
If you want run more saving scenarios, the government’s Money smart compound interest calculator is a good place to start.
Compound interest is low effort
When it comes to investing, there are certainly other options including property, shares and stock. It’s all about personal choice and what you’re comfortable investing in. But, if you’re someone who likes to ‘set and forget’, rather than play the investment game, setting up a savings account with compound interest could be the low effort option you’re looking for.
Get started ASAP with an account that earns compound interest.
A key takeaway from the above examples is that the sooner you start, the more you stand to benefit. Whether your initial deposit amount is small or big, it’s all about getting time on your side and using that time, plus a commitment to regular deposits, to harness the power of compound interest.
Ubank’s Save account comes with bonus interest on combined savings up to $1M per customer when you meet our bonus interest criteria. Plus, you can get set up in minutes and begin compounding interest today.
